# Business Model Design

Defining how a venture creates, delivers and captures value — customers, offer, channels, cost structure and revenue.

**Rests on:** Business Plan Writing

**Leads to:** Business Acquisition, Exit and Selling, Franchising, Startup Financing

*Business, Career and Human Factors · Entrepreneurship*


## Why learn this

Understanding business model design lets you see why some ventures thrive and others collapse, even with identical products. It gives you the language to describe how money actually moves — who pays, what for, and what it costs to deliver. This unlocks practical skills in Business Plan Writing (where the model is documented and stress-tested), Startup Financing (where the model determines how much capital you need and what you can afford to promise), and later, Product Management (where the model decides which features are worth building). It also connects to your notes on Franchising — where the business model itself is the product being sold — and to SWOT Analysis, which often reveals threats that are really flaws in the model.


## The intuition

Think of a business as a machine that turns effort into money. The business model is the blueprint of that machine — not the product itself, but how the machine is arranged. It answers five questions: Who are we serving? What exactly are we giving them? How do we reach them? What does it cost to run the machine? And where does the money come in? Without a blueprint, you can have a brilliant product that still goes bankrupt — because customers can't be reached, or the cost of serving them exceeds what they pay. The model is not a spreadsheet; it is a logic chain that says 'if these people need this, and we can give it to them at this cost, then they will pay us more than it costs us, and the business will live.' Change any one link — the customer, the offer, the channel, the cost, or the revenue — and the whole machine changes. That is why pivots are usually model changes, not product changes.


## An analogy

Imagine a farmer with a field of mangoes. The mangoes are the product. The business model is how the farmer turns them into income. Option A: he sells mangoes by the roadside — customers drive by, he hands them a mango, they hand him cash. That is a simple model: customer is the driver, offer is the mango, channel is the roadside stall, cost is growing and picking, revenue is per mango. Option B: he sells mangoes to a juice factory — now the customer is the factory, the offer is a bulk supply contract, the channel is a delivery truck arrangement, the cost is the same, but the revenue is a fixed price per ton. Option C: he starts a subscription — customers pay a monthly fee for a box of mangoes delivered every week. Same mangoes, same field, but the machine has different parts: the customer is now a household, the channel is a courier, the cost includes packaging, and revenue is recurring rather than one-off. The analogy stops working when you think the model is fixed. A farmer can't easily change his field, but a business can redesign its model — change the customer, the offer, even the revenue — and the same asset can produce a different machine. Also, the analogy underplays reach: a roadside stall reaches only those who pass, whereas a digital channel can reach millions. Still, the core idea holds: the model is the arrangement, and the same inputs can be arranged different ways.


## Definition

A business model is the design of how a venture creates value for a customer (the offer), delivers it (the channels and operations), and captures value for itself (the revenue and cost structure that together produce profit).


## How it connects

This is the first brick in your Entrepreneurship notes. You already have notes on Business Plan Writing — the business model is the heart of what that plan documents. Your notes on Startup Financing say that equity is the most expensive capital if the company succeeds — the model is what makes that success possible, because it determines whether revenue exceeds costs. And your note under Crowdfunding says the campaign validates demand — a business model is the fuller version of that validation: not just 'will people pay?' but 'will they pay enough, reliably, at a cost we can sustain?' The model is also the lens through which your Business Acquisition notes make sense — you acquire a business precisely because its model is already generating cash flow that can be transferred.


## The mathematics

A business model is a way of describing how money moves in and out of a company. To understand it, we do not need calculus, probability, or complex algebra. We only need the four basic operations: addition, subtraction, multiplication, and division. The core idea is simple: a business makes money by selling things, spends money to make those things, and keeps the difference.

We can describe this process with three numbers that change together as the business grows:

1. Revenue: The total money coming in from sales.
2. Cost: The total money going out to run the business.
3. Profit: The money left over after paying all costs.

Revenue is calculated by multiplying two things: the price of one item and the number of items sold. If you sell more items, your revenue goes up in direct proportion.

Cost has two parts:
- Fixed cost: Money you must pay no matter how many items you sell (like rent or salaries). This number stays the same.
- Variable cost: Money you spend for each item you make (like materials or shipping). If you make more items, this total cost goes up.

Total Cost is the fixed cost plus the variable cost for all items. Profit is Revenue minus Total Cost.

To make this concrete, let us define five symbols. Each symbol stands for a specific real-world quantity:

- N: The number of units sold in a given period (e.g., one month). This is a count, so it is a whole number like 100 or 500.
- p: The price charged for one unit. This is a positive number, such as 100 rupees.
- v: The variable cost to produce or deliver one unit. This is also a positive number, such as 30 rupees.
- F: The fixed cost for the period. This is a positive number that does not depend on N, such as 10,000 rupees for rent.
- P: The profit for the period. This is the final result we want to find.

The calculation happens in two stages.

Stage 1: Calculate Revenue and Variable Cost separately.
Revenue is p multiplied by N. In words: take the price per cup and multiply it by the number of cups sold.
Variable Cost total is v multiplied by N. In words: take the cost to make one cup and multiply it by the number of cups sold.

Stage 2: Calculate Profit.
First, find the Gross Contribution. This is Revenue minus Variable Cost total. It represents the money left from each sale after paying for the materials of that specific sale. Mathematically, this is (p times N) minus (v times N). Because both terms have N, we can factor it out: N times (p minus v). This means you take the profit margin on a single cup (price minus variable cost) and multiply it by how many cups you sold.

Second, subtract the Fixed Cost F from the Gross Contribution. This gives us Profit P.

So the full formula is:
P = [N times (p minus v)] minus F

Let us read this formula in plain English:
"Take the number of units sold. Multiply that by the money left over from each unit after paying for its materials. Then subtract the monthly rent."

Why do we write it this way? Because it shows how profit changes as N changes. The term (p minus v) is always positive if the price is higher than the variable cost. As N gets larger, the first part [N times (p minus v)] gets larger. The fixed cost F stays the same. Therefore, as you sell more units, your profit increases by a constant amount for each additional unit sold.

This formula is not new mathematics. It is just a compact way to write the steps you would take on paper. It allows us to see the relationship between sales volume and profit clearly.


## A worked example

Let us apply this to a small coffee stall. We will use real numbers for every symbol.

The setup:
- Fixed cost (F): The stall rents space for 10,000 rupees per month. This is paid regardless of sales.
- Variable cost per unit (v): Each cup of coffee costs 30 rupees in beans, milk, and cups.
- Price per unit (p): The stall sells each cup for 100 rupees.

We will calculate the profit for two different scenarios: selling 200 cups and selling 500 cups.

Scenario A: Selling 200 cups
Here, N = 200.

Step 1: Calculate Revenue.
Revenue is price times quantity.
Revenue = 100 rupees/cup × 200 cups
Revenue = 20,000 rupees.
This is the total cash coming into the stall.

Step 2: Calculate Total Variable Cost.
Total variable cost is variable cost per unit times quantity.
Variable Cost = 30 rupees/cup × 200 cups
Variable Cost = 6,000 rupees.
This is the cash spent on materials for these 200 cups.

Step 3: Calculate Gross Contribution.
Gross Contribution is Revenue minus Total Variable Cost.
Gross Contribution = 20,000 rupees − 6,000 rupees
Gross Contribution = 14,000 rupees.
This is the money available to pay for fixed costs and profit.

Step 4: Calculate Profit (P).
Profit is Gross Contribution minus Fixed Cost.
P = 14,000 rupees − 10,000 rupees
P = 4,000 rupees.

Result for Scenario A: The monthly profit is 4,000 rupees.

Scenario B: Selling 500 cups
Here, N = 500. The prices and costs per unit (p=100, v=30) and the fixed cost (F=10,000) remain the same.

Step 1: Calculate Revenue.
Revenue = 100 rupees/cup × 500 cups
Revenue = 50,000 rupees.

Step 2: Calculate Total Variable Cost.
Variable Cost = 30 rupees/cup × 500 cups
Variable Cost = 15,000 rupees.

Step 3: Calculate Gross Contribution.
Gross Contribution = 50,000 rupees − 15,000 rupees
Gross Contribution = 35,000 rupees.

Step 4: Calculate Profit (P).
P = 35,000 rupees − 10,000 rupees
P = 25,000 rupees.

Result for Scenario B: The monthly profit is 25,000 rupees.

Comparison:
When sales increased from 200 to 500 cups (an increase of 300 cups), the profit increased from 4,000 to 25,000 rupees (an increase of 21,000 rupees).
Notice that the fixed cost of 10,000 rupees was paid in both cases. It did not change. The extra profit came entirely from the contribution of the additional 300 cups.
Each additional cup contributes (100 − 30) = 70 rupees to profit. 
300 cups × 70 rupees/cup = 21,000 rupees.
This matches the difference in profit exactly: 25,000 − 4,000 = 21,000.

This demonstrates that once fixed costs are covered, every additional unit sold adds directly to profit by the amount of (price minus variable cost).


## Common misconceptions

**A business model is just how you make money** — The business model is just the revenue model — how I charge customers.

Revenue is only one of the five pieces: customers, offer, channels, cost, and revenue. A subscription model can still fail if the cost of serving each customer exceeds the fee, or if the channel does not reach the right customers. In fact: The business model is the whole system — who you serve, what you give them, how you reach them, what it costs, and how you charge. Revenue is one dimension; cost structure, channel, and customer are equally decisive.

**A better product means a better business model** — If my product is better than the competitor's, the business will succeed.

Many great products fail because the model cannot deliver them profitably. The cost of reaching customers, or the price customers will pay, can make a superior product economically unviable. In fact: The business model decides whether a product becomes a viable venture. A product is necessary but not sufficient — the model must turn it into profit.

**The business model is fixed and permanent** — Once I've designed my business model, that's the plan I stick with.

Your own notes say most pivots are business model changes, not product changes. Models evolve as you learn about customers and costs. In fact: A business model is a living design. It should be revisited as you test assumptions, see costs, and observe customer behaviour.

**Profit is the same as cash flow** — If my profit calc says I'm profitable, I have enough cash to pay my bills.

Profit is an accounting measure; cash flow is actual money moving in and out. You can be profitable on paper but run out of cash if customers pay late or you must pay suppliers upfront. Your Entrepreneurship notes explicitly say cash flow, not profit, is what kills companies. In fact: Profit is the net of revenue and costs; cash flow tracks the timing of money. A business can be profitable yet still die from a temporary cash shortfall.

**The business model is the same as the business plan** — The business model is the business plan — they're basically the same thing.

A business plan is a document that explains the model, market, operations, and financials. The model is the underlying logical design; the plan is the communication of it. In fact: The business model is the substance; the business plan is the expression. As your notes say, the value of the plan is the reasoning it forces, not the artifact itself.


## In short

A business model is the blueprint for how a venture creates, delivers, and captures value. It has five parts: customers, offer, channels, cost structure, and revenue. The mathematical heart is simple arithmetic: profit = quantity × (price − variable cost) − fixed cost. The model determines whether scale helps or hurts, and most pivots are changes to the model, not the product. Look at every business through these five questions and you will quickly see why some models work and others fail.


## Where this is used

Business model design is everywhere in AI, and not just for the AI vendors themselves. For a founder building an AI product, the model determines whether the AI is a feature or a product. For example, consider an 'AI legal assistant' that helps small businesses review contracts. The model might be: customers pay a monthly subscription (revenue), the AI runs on cloud servers whose cost scales with usage (variable cost), and the startup has a team of lawyers who refine the model (fixed cost). The formula above applies directly — price per subscription, variable cost per user (compute), fixed cost of staff and infrastructure. The choice of model can make or break the venture. If the founder charges a flat rate but compute costs rise with each document processed, then the variable cost per user is high, and the profit margin shrinks as usage grows — the model may lose money on heavy users. Alternatively, a usage-based model (pay per contract analysed) aligns revenue with cost but may scare customers who prefer predictable pricing. In large language models (LLMs) themselves, the business model of the provider determines how the model is served. A company like OpenAI sells access via API, where each token has a price — a variable cost, but the fixed cost of training was enormous (billions of dollars) and is sunk. The model must capture enough revenue per user to cover that fixed cost, so the pricing often has a per-token charge plus a subscription for heavy users. In small language models running on a phone or laptop, the model cost structure is different: the software has a fixed development cost, but the marginal cost of serving each additional user is near zero — the model is distributed as an app, and revenue comes from one-time purchase or subscription, with the variable cost being mostly support. In retrieval-augmented generation (RAG), a company's business model might be to sell a search service over a private knowledge base. The revenue is a subscription per employee, and the cost includes hosting, embedding computation, and prompt tokens. Here the variable cost is per query, so the design must set prices high enough to cover token usage at full scale. The developer using a RAG library like LangChain or LlamaIndex writes code that calls an embedding model and a vector database; the business model decides whether the app charges per query or per seat. In agentic systems — where the AI plans, calls tools, and acts in a loop — the business model is often outcome-based: e.g., an 'AI procurement agent' that negotiates prices with suppliers charges a percentage of savings. The cost is the compute per step of the agent, but the revenue is a fraction of a larger monetary benefit, so the model must ensure that the agent's benefit exceeds its compute cost per task. Developers building such agents write orchestration code (e.g., using LangGraph) that tracks tool calls; the business model determines the pricing metric, such as per successful task. In everyday applied machine learning, such as recommendation or fraud detection, the model is a component inside a larger existing business. The business model is not the AI itself but the underlying service — say, e-commerce — and the AI drives conversion or reduces fraud. Here the cost side includes model training and inference; the revenue side is the lift in sales or the reduction in fraudulent losses. A developer builds a pipeline where the model scores each transaction; the business model decides whether the model is worth its cost. A real example from the notes: the textbook 'Small Business: Creating Value Through Entrepreneurship' frames business acquisition as a four-step process — raise capital, identify targets, fund the buyout, then create value through management. The business model of the acquired business is what you are buying: you are purchasing its cash flow, which is the output of its model. An acquirer looks for a model with strong unit economics — high revenue per customer, low variable cost — and with transferable, documented cash flow, as your Exit notes say. The model design is the lens for due diligence: if the cost structure depends on the founder's personal network, the model may not survive a change of management.


---

Read this on the web: https://basavapurushottam.com/learn-ai/business-model-design
